Chapter 15: Ratio Analysis

Question 1

Dividend yield calculation

Answer 1

Dividend yield = Dividend per share / Market Price per share x 100%

Question 2

What may low dividend yield indicate

Answer 2

A high growth company or overvalued share price

Question 3

How are yields related to prices?

Answer 3

Inversely related

Question 4

What does the dividend cover calculate?

Answer 4

• looks at how many times a company could have paid out its dividends based on the profit for the year
• important measure of safety of a dividend
• the higher % the better

Question 5

Dividend cover calculation

Answer 5

Dividend cover = earnings per share / dividend per share

Question 6

What does Payout Ratio measure?

Answer 6

The sustainability of a company’s dividend policy. The lower % the better

Question 7

Payout Ratio Calculation

Answer 7

Payout ratio = dividend per share / earnings per share

Question 8

Difference between absolute and relative valuation techniques

Answer 8

• Absolute = based on discounting, used to estimate present value of future return
• Relative = estimates value as some measure of earnings power times a multiple

Question 9

Earnings Per Share Calculation

Answer 9

EPS = Profit available to ordinary shareholders / number of ordinary shares
* Calculates AFTER all other expenses have been made by the company

Question 10

What is diluted EPS

Answer 10

• worst-case scenario
• assumes that any potentially dilutive securities are converted into ordinary share
• thus the number will be lower as the amount of ordinary shares will be greater

Question 11

P/E Ratio

Answer 11

• measures how highly investors value a company as a multiple of its earning
• Market Price per share / earnings per share

Question 12

What does a high P/E ratio relative to its sector average reflect?

Answer 12

• That investors expect the company to achieve above average performance growth

Question 13

EBIDTDA multiple

Answer 13

• uses ratio earnings before interest, tax, depreciation and amortization –> excludes items that can be inconsistently calculated for P/E
• more comparable measure, comparing the market value of capital from all providers with a measure of profit available to them
• EBITDA = earnings before interest, tax, depreciation + amortization

Question 14

Main 2 weaknesses of P/E

Answer 14

• based on accounting profits, including estimates
• loss making companies display negative P/E ratios, not based on long-term prospects

Question 15

3 alternatives to multiples

Answer 15

• Price to Book
• Price to Sales
• Price to cash flow

Question 16

Gearing

Answer 16

• quantifies the relationship between the proportion of the capital being debt financed and the proportion that is provided by shareholders
• Debt/Capital Employed
  Capital Employed = Debt + Equity

Question 17

Is interest or dividend paid out first?

Answer 17

• interest

Question 18

What is the ability for a company to pay their liabilities

Answer 18

• Liquidity

Question 19

Current Ratio Calculation

Answer 19

Current Assets / Current Liabilities
* calculate liquidity

Question 20

Quick Ratio

Answer 20

Current Assets - Stocks / Company Liabilities
* calculates liquidity

Question 21

Operational gearing calculation

Answer 21

(Sales Revenue - Variable Cost) / Trading Profits

Question 22

ROCE

Answer 22

• Return on Capital Employed
• Measure of profitability relative to size
• Profits Before Interest and Tax / Capital Employed x 100

Question 23

Operating Profit margin

Answer 23

• Looks at how efficient a company is in turning their sales into profit
• Operating profit / Sales

Question 24

Asset Trunover

Answer 24

Revenue / Total Assets

Question 25

How may a rights issue affect the accounting ratios?

Answer 25

• raises more capital –> fall in ROE and ROCE

Question 26

How may a share buy-back affect the accounting ratios?

Answer 26

• increase ROE, ROCE and gearing and EPS

Question 27

How may a script / bonus issue affect the accounting ratios?

Answer 27

• will dilute earnings per share but should have no impact on ROE or ROCE